CHIPOTLE MEXICAN GRILL INC CMG S
December 23, 2010 - 9:53am EST by
heffer504
2010 2011
Price: 233.00 EPS $5.50 $6.50
Shares Out. (in M): 32 P/E 42.0x 36.0x
Market Cap (in M): 7,500 P/FCF nm nm
Net Debt (in M): 0 EBIT 280 330
TEV: 7,500 TEV/EBIT 27.0x 23.0x
Borrow Cost: NA

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Description

My fourth submission for your insanely overvalued short portfolio is Chipotle. 

1)  The recent positive sales performance is more a function of a poor 2009 than a great 2010.  While "bulls" will point to strong comparable store metrics, I would point out that this metric is flawed for growing concepts.  Specifically, if in a typical year, Chipotle units open at $1.4m and reach maturity at $1.8m in a few years, those units that opened in the depths of the 2009 depression likely have an even bigger ramp-up.  Since over 10% of the store base was opened in this period, it is possible that these stores comped nearly 40%, implying that the mature stores comped 6-7% in the company's last quarter.  While this is still healthy, it is against a traffic decline of 8% the year-ago quarter, so it is basically just getting back to 2008 levels.  Overall, sales per restaurant are basically unchanged over three years, despite a large price increase and the maturation of the store base, implying negative traffic over this time period. 

2)  The company has guided for "low single-digit" comps for 2011.  Considering that sales/store have increased at 200 bps over inflation in the last five years, this seems like reasonable guidance.  One can only assume that those paying 40x earnings are assuming much better results.  I would add then when a restaurant sells basically one product, with little variation or limited-time offers to drive traffic, along with already-crowded locations, then traffic growth should be expected to be low.  Finally, given that Chipotle benefited from television exposure (through Oprah and paid advertising) for the first time in 2010, it will be cycling relatively difficult sales comparisons.

3)  The product is not cheap, at a $10-12 average check.  As such, it will be limited in its appeal.  For example, while there are 29 restaurants in Manhattan, there is one restaurant in all other New York City boroughs combined-this is a concept for those with a lot of disposable income.  Management has discussed 2,000 units which seems reasonable.  In addition, half of the units being opened are new, smaller formats, which indicates a lack of growth opportunities for the larger units.

4)  The company currently has among the best profitability in the restaurant industry, at 25% EBITDA restaurant-level margins.  Assuming these margins can hold, $1.8m of sales per mature location, and $100 million of corporate overhead, all of which are aggressive, and applying the top-end multiple for a mature concept of 8x EBITDA, the current valuation implies that the 2,700 restaurants are in existence today (i.e., undiscounted), though it would take over a decade to build out that number.  This, in my opinion, is staggering.  Using an 8% discount rate you can assume 3,000 stores and get to a current value of $120 today.

5)  Costs will likely escalate, as the company, despite claiming to buy only organic and naturally-raised ingredients, has been buying cheaper proteins recently due to supply constraints.  This, combined with general food inflation, will likely be a headwind in 2011.

6)  Insiders are selling stock at a record clip.

7)  Ten sell-side analysts have "buy" recommendations on the stock (sixteen have holds, none have sells).  The target price is below the current price.

So, to summarize, Chipotle has seen negative traffic growth over the last three years, has guided to mediocre future growth, and is already pricing in a tripling of the store base overnight.  The stock has doubled since August while earnings estimates for 2011 have increased roughly 10%. 
(please note that the bulk of this writeup came from an investment fund's monthly letter)

Catalyst

cycling of very tough comps in 1q11 due to the Oprah effect
the realization that LSD comps are the norm for this concept (ie taking management at their word) and that the current multiple is therefore inappropriate
cost pressures drive pricing increases, which have a negative impact on traffic as they have done historically
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    Description

    My fourth submission for your insanely overvalued short portfolio is Chipotle. 

    1)  The recent positive sales performance is more a function of a poor 2009 than a great 2010.  While "bulls" will point to strong comparable store metrics, I would point out that this metric is flawed for growing concepts.  Specifically, if in a typical year, Chipotle units open at $1.4m and reach maturity at $1.8m in a few years, those units that opened in the depths of the 2009 depression likely have an even bigger ramp-up.  Since over 10% of the store base was opened in this period, it is possible that these stores comped nearly 40%, implying that the mature stores comped 6-7% in the company's last quarter.  While this is still healthy, it is against a traffic decline of 8% the year-ago quarter, so it is basically just getting back to 2008 levels.  Overall, sales per restaurant are basically unchanged over three years, despite a large price increase and the maturation of the store base, implying negative traffic over this time period. 

    2)  The company has guided for "low single-digit" comps for 2011.  Considering that sales/store have increased at 200 bps over inflation in the last five years, this seems like reasonable guidance.  One can only assume that those paying 40x earnings are assuming much better results.  I would add then when a restaurant sells basically one product, with little variation or limited-time offers to drive traffic, along with already-crowded locations, then traffic growth should be expected to be low.  Finally, given that Chipotle benefited from television exposure (through Oprah and paid advertising) for the first time in 2010, it will be cycling relatively difficult sales comparisons.

    3)  The product is not cheap, at a $10-12 average check.  As such, it will be limited in its appeal.  For example, while there are 29 restaurants in Manhattan, there is one restaurant in all other New York City boroughs combined-this is a concept for those with a lot of disposable income.  Management has discussed 2,000 units which seems reasonable.  In addition, half of the units being opened are new, smaller formats, which indicates a lack of growth opportunities for the larger units.

    4)  The company currently has among the best profitability in the restaurant industry, at 25% EBITDA restaurant-level margins.  Assuming these margins can hold, $1.8m of sales per mature location, and $100 million of corporate overhead, all of which are aggressive, and applying the top-end multiple for a mature concept of 8x EBITDA, the current valuation implies that the 2,700 restaurants are in existence today (i.e., undiscounted), though it would take over a decade to build out that number.  This, in my opinion, is staggering.  Using an 8% discount rate you can assume 3,000 stores and get to a current value of $120 today.

    5)  Costs will likely escalate, as the company, despite claiming to buy only organic and naturally-raised ingredients, has been buying cheaper proteins recently due to supply constraints.  This, combined with general food inflation, will likely be a headwind in 2011.

    6)  Insiders are selling stock at a record clip.

    7)  Ten sell-side analysts have "buy" recommendations on the stock (sixteen have holds, none have sells).  The target price is below the current price.

    So, to summarize, Chipotle has seen negative traffic growth over the last three years, has guided to mediocre future growth, and is already pricing in a tripling of the store base overnight.  The stock has doubled since August while earnings estimates for 2011 have increased roughly 10%. 
    (please note that the bulk of this writeup came from an investment fund's monthly letter)

    Catalyst

    cycling of very tough comps in 1q11 due to the Oprah effect
    the realization that LSD comps are the norm for this concept (ie taking management at their word) and that the current multiple is therefore inappropriate
    cost pressures drive pricing increases, which have a negative impact on traffic as they have done historically

    Messages


    Subjectheffer
    Entry12/23/2010 10:31 AM
    Memberzzz007
    I see where you are going with this insanely overvalued short basket.  It's like the VIC version of the 12 Days of Christmas.  A present each day.

    Subjectfor the record
    Entry05/08/2012 08:25 AM
    Memberheffer504
    with the recent declines of gmcr, elektra, fosl, and a few others, i thought i would revisit my posts.  currently, chipotle is the only real outlier of the last ten shorts that i have posted.  i believe that this the year that people will understand the limitations of the concept and re-rate the stock dramatically.  
     
    - heffer

    SubjectRE: RE: for the record
    Entry07/20/2012 06:59 AM
    Memberheffer504
    we will see...  i do think they are at the point where they cannot raise prices much more, since $10 is the barrier for fast casual. 
     
    also interesting was the piece in the NY Times today that the company has a national policy of offering discounts of up to 50% to police officers.  bribing cops and hiring illegal immigrants while misrepresenting that all the food served is organic, maybe there is a pattern of bending the rules here...
     

    SubjectRE: RE: RE: for the record
    Entry04/23/2013 06:13 PM
    Memberstraw1023
    heffer/andreas,
     
    an update with the bounceback?
     
    I have this trading at 30x unlevered FCF (taking out cash and figuring maint capex at $50mm after taking out $800k per new store). SSS for 2013 is 0-2%. I would point out that since CMG starts counting comps at 13 months, their SSS is a bit inflated towards a "true" SSS as store sales ramp for longer than a year.
     
    They are opening stores at +12.5% pace in 2013. Do you still think 3,000 stores is upper limit?
     
    I have also started to hear anecdotal complaints about quality of service/cleanliness and the amount of salt in the food.
     
    I have been on the sidelines for years, but might get back in. 

    SubjectRE: RE: RE: RE: for the record
    Entry04/24/2013 08:06 AM
    Memberheffer504
    so just for the record, i posted that update when the stock was over $400, and it went to $236.  but, now that it has rebounded, i would just make the following comment: data does not matter.  this stock is too expensive, along with many, many others.  last quarter was fine, nothing great or terrible, certainly not beating the way they were back in 09 and 10 when analysts just didn't understand how easy their traffic comps were.  the thesis on this one is the same, and is widely known.  the movements have much more to do with the fact that the stock is heavily shorted than anything else for now.  sorry can't be more helpful..
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